Tax concessions for retirees
Policymakers and commentators would do well to keep in mind that superannuation is only one of a wide range of investment options open to retirees. Indeed, for retirees with SMSFs in particular, their superannuation is often only a part of their investment portfolio.
The tax exemption on earnings on assets supporting pensions is often put forward as a compelling reason to keep money invested in superannuation in retirement. However, tax concessions currently offered to older Australians mean that many retirees would not pay income tax even if they held their savings outside the superannuation environment. Any changes to the taxation of superannuation should be mindful of this.
Proposals for a tax on pensions
In light of the deterioration in government finances, a number of commentators have suggested introducing a tax on earnings in pension phase. Often these proposals come with the sweetener of a reduction in the tax on earnings in the accumulation phase to make the change more palatable to the electorate.
One such proposal floated in the media estimated that setting a tax on all superannuation earnings at 10.5 per cent would raise the same revenue as the current 15 per cent tax on accumulation earnings. With our ageing population leading to a higher proportion of assets in pension phase, it was predicted that this policy would increase the overall tax take in the longer term.
Unintended consequences
However, our analysis suggests that such a measure alone would most likely have completely the opposite effect; it would drastically reduce the total amount of superannuation savings in Australia and the tax accrued from those savings.
Simply put, if retirees behave rationally in response to such a policy, then most would remove much or all of their superannuation in favour of better tax-sheltered investments. In fact, if the tax rate in the accumulation phase is reduced as part of the same policy, the ATO should expect to see a significant reduction in the total tax take from superannuation and at the same time we may see a reduction in Australians’ retirement incomes.
Let’s look at how such a policy might impact a fairly typical couple retiring at age 65, who own their own home and have $400,000 in superannuation savings between them as well as limited other savings.
Under the current regime, if they choose to keep their savings in the superannuation environment and commence account-based pensions, then earnings on those assets are exempt from tax. Whether they look to take advantage of the flexibility of an SMSF or the relative simplicity of an APRA-regulated fund, they have a wide range of tax-efficient investments to choose from within super.
Introduce a tax on earnings in the pension phase and our couple must think twice about leaving their savings in superannuation. If they withdraw their savings and invest them outside superannuation then the income earned would form part of their assessable income for tax purposes.
A reasonably balanced investment strategy in retirement might yield around 5 per cent per annum on average over the long term – say $20,000 in income on their current $400,000 in savings. When we allow for the Seniors and Pensioners Tax Offset this is below the threshold at which they would start paying income tax, even taking into account their age pension entitlements. From a tax perspective, they would be better off investing their money outside of superannuation.
In fact, if a tax of 10.5% per cent on pension earnings was introduced, we estimate that our couple would need retirement savings of over $1.5 million between them in order for it to be tax-efficient to leave their savings in super compared to outside. This is again based on achieving a 5 per cent per annum return both inside and outside superannuation.
Clearly, this is going to impact on the amount of money retirees choose to keep invested in super. These proposals assume retirees keep pumping their retirement savings into superannuation pensions at the current rates, despite the fact they will be worse off tax-wise. We don’t believe that this is likely, particularly for well advised SMSF trustees, and therefore the expected levels of tax will not materialise. Policies that also reduce the tax rate on accumulation assets are more likely to reduce the overall tax take.
We would go further and suggest that incentivising people to take their savings out of the superannuation environment may also be detrimental to their retirement outcomes. For the less financially literate, choosing your own investments outside the regulated superannuation environment may lead to less appropriate investment, perhaps resulting in lower returns. Removing the self-imposed discipline of setting up a pension to provide a regular income could also lead to retirees spending their savings faster and falling back on the age pension sooner.
Doug McBirnie, consulting actuary, Bendzulla Actuarial
I also thought so but I must warn practitioners that, judging from an ANU lunchtime tax discussion we went to yesterday, most commentators are woefully ignorant of points made here. The only person who made sense was Chris Jordan the Commissioner of Taxation who pointed out the normal SMSF balance of $480,000 only amounted to a pension of $24,0000 per year.
Good points here.
This makes some valid points. However a look at just how SMSF should be taxed whether in pension phase or acculmulation is kinda lost on all the middle class whom will struggle to get to the big SMSF balances that are being commented on. Any discussion on tax needs to really examine the whole economic picture and work out where the deficiences are. If the government don’t step up and do that then the next generation of taxpayers will have hell to pay.
[quote name=”Louise Drolz”]
In my mind, the taxation of pension asset earnings and/or removing the refundable status of franking credits is, along with the re-introduction of some form of RBL, a no-brainer.[/quote]
That may turn out to be literally true. Nothing would surprise me about our politicians and policymakers. How a country with the highest resource endowment per capita in the world got into this mess is a sad story of no brains for years. We can’t or won’t collect land and resource rents so we punish our breeding taxpayers – and wonder why there are declining numbers of PAYE taxpayers. The Emperor Tiberius has more sense when he remarked that the shepherd shears his sheep, he does not flay them.
A ax on pension asset earnings is inevitable, particularly with regard to franking credits. Australia can’t sustain an economy in which the population is ageing and the contribution to general revenue from the taxation of corporations diminishes as more assets are held in super pensions.
In my mind, the taxation of pension asset earnings and/or removing the refundable status of franking credits is, along with the re-introduction of some form of RBL, a no-brainer.
[quote name=”Ralph”]
I am not entirely convinced by the argument that there will be a mass exodus out of super. The tax advantages in accumulation mode outweigh having funds invested outside super. Moving all your assets out of a lower tax environment (even if taxed at 10%) into a fully taxed environment would presumably incur capital gains and directly affect pension payments. Whilst it may be beneficial for those with low balances, any benefit quickly evaporates.[/quote]
True, nothing is as good as an SMSF in pension mode. But, having done some comparisons and calculations, I am sure that one can get pretty close to an SMSF in accumulation phase without any of the preservation and excess contribution headaches.
For families, getting rid on non-deductible interest home loans and income splitting are usually better strategies for a start. There are other investment choices later.
I think it is inevitable that SMSF’s will loose their tax free status once a pension is commenced. If for no other reason then the size of the asset pool and the fact that the majority have significant investments in dividend paying Australian companies.
Once in pension mode a SMSF gets back all the franking credits tax free, so that creates a large and increasing drain on tax revenues.
I am not entirely convinced by the argument that there will be a mass exodus out of super. The tax advantages in accumulation mode outweigh having funds invested outside super. Moving all your assets out of a lower tax environment (even if taxed at 10%) into a fully taxed environment would presumably incur capital gains and directly affect pension payments. Whilst it may be beneficial for those with low balances, any benefit quickly evaporates.
A rational contribution to debate which is altogether too rare.
Of course there are other investment structures! We can certainly think of a few.
Exactly right. I don’t know why the effects noted here weren’t thought of before the original idea ended up in newspapers.
Spot on Doug.
Too many ill informed commentators and politicians should just butt out, or learn some facts before making stupid proposals.
What is seriously needed is a complete review of our Tax Laws and the removal of the huge differential between the Company Tax rate and the top marginal personal tax rate. (And Abbott made the difference even bigger! Figure that out!) The Henry Report started the review process, but politics got in the way of a rational response by government. I don’t hold out any prospect that Abbott has the guts to address this issue.
A tax on pension assets would it work?
Consider the old 30/20 rule as an annuity or life time pension into INFRASTRUCTURE. There is a major problem with franking credits within a tax free superannuation pension.